Most South Africans are not aware of how much time is left before retirement. They don’t have a financial plan in place to settle debts and start investing. Unfortunately, the majority of income earners will have to drastically downgrade their lifestyles on retirement, when regular income stops coming in.
Most employees earn approximately 480 pay cheques in their working lifetime, which is typically from age 25 to 65. The average person can expect to live until at least 85. This means they need to use this limited number of pay cheques to fund a retirement income for at least 240 months. In the current environment, it can be challenging for individuals to meet basic day-to-day expenses without getting into debt. Therefore, any successful retirement strategy must include a debt repayment plan.
Ideally, all debt commitments should be cleared by age 45. This allows enough time to boost retirement fund contributions instead of paying interest over to the bank. In the worst-case scenario, the aim should be to have no debt by age 60. This means that from at least the age of 45, debt repayments should be a top priority.
Four essential elements to be debt-free by retirement
1. A home loan shouldn’t be an ATM
By the age of 45, there are only 15 years left to achieve the goal of being debt-free. Individuals buying a home at the age of 45 should ensure that the loan term does not exceed 15 years. Investors with an existing bond should not be drawing down capital from an access bond, unless there is a plan in place to settle this debt in a shorter time period. This is particularly important for those looking to use this capital to pay for home renovations or children’s education.
2. Eliminate short-term debt
Short-term debt could derail retirement planning, so paying this off is critical. Draw up a list of the short-term debts and work out the date on which the last debt will be paid off. Those who find that their debts will not be paid in time for retirement should make significant lifestyle changes now in order to accelerate their debt repayments. Debt consolidation might be a solution as it reduces multiple payments to one payment over a shorter period of time. It is essential that no further debts are taken on during this time.
3. Be realistic about university fees
If no savings and investments have been set aside for tertiary education, don’t be tempted to take out additional debt. Be realistic about affordability as children should not have to carry the burden of financially supporting their parents during retirement.
Children could apply for bursaries, student loans or turn to other family members for financial assistance. Of course, the main breadwinner could assist in paying off the interest on these loans, but the child should take responsibility for the student debt when entering the workforce.
4. Don’t use pension money to pay off debt
It may be tempting to cash in on investments that are producing above-inflation returns to pay off debt with higher interest rates. However, individuals will miss out on the power of compound growth should they go this route.
Say, for example, you are considering cashing in your investments to squash R100 000 of short-term debt. If you rather focused on paying off the debt by budgeting and cutting back, you could probably pay it off within five years. This would translate to a payment of R2 900 per month, but could be reduced by putting bonuses and tax rebates towards the debt.
Over five years, at an interest rate of 25%, the individual would spend R174 000 to settle the R100 000 of debt. It takes discipline to start saving R2 900 per month. In the meantime, if the R100 000 is growing at 10% per annum, and doubles in value every seven years, it will be worth R200 000. And after 14 years it is worth R400 000 and after 21 years, you’re sitting on R800 000.
The same applies to home loans. While cashing in your retirement fund to be mortgage-free means you don’t have a mortgage repayment, you still need retirement funds to pay for your day-to-day expenses.
Don’t pay off debt with your nest egg – make the necessary lifestyle changes instead.
Phillip Kassel is a financial advisor at Liberty.
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This article does not constitute tax, legal, financial, regulatory, accounting, technical or other advice. The material has been created for information purpose only and does not contain any personal recommendations. While every care has been taken in preparing this material, no member of Liberty gives any representation, warranty or undertaking and accepts no responsibility or liability as to the accuracy, or completeness, of the information presented. Please consult your financial advisor should you require advice of a financial nature and/or intermediary services. Liberty Group Limited is a Registered Long-Term Insurer and an Authorised Financial Services Provider (FAIS No 2409).